Many of my clients make occasional loans to their children. A few of these loans have actually been repaid, or at least partially repaid.
The problem is that if you make a loan to your child for his new business, and the child’s new business experiences temporary or permanent financial losses, the child can’t take a deduction for the loss because the child has no basis and no income, and you only get a capital loss that can only be offset against capital gains.
A better approach may be to establish a partnership with your child and file it as an LLC. Then you contribute cash to the LLC instead of loaning the money to your child. If you include special allocations language in the LLC providing that all losses are allocated to the partners according to their tax basis, then you get to take 100% of the losses as a business loss which you can offset against ordinary income (subject to passive activity limitations).
If you loan $200,000 to your child and suffer a total loss, the difference between a capital gain and ordinary income could be 20%, or $40,000.
So before you plow ahead with a loan to your child, you should consult with your tax advisors and see if a better structure will give you additional tax benefits. Who knows, maybe you will be lucky and your tax advisor will talk you out of making the loan altogether!